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Cheapest home loans might not be the best for you

Last week State Bank of India (SBI) announced a further reduction in its home loan rates across different amounts of loans. While this is no doubt going to be beneficial to all of us by improving our affordability, there is more to this than meets the eye. We should not be tempted to blindly go in for these relatively cheaper home loans as it could come back to hurt us in later years. Read more...

1. The facts - how do cheap home loan rates work?
2. But, aren't cheaper rates good for me?
3. What am I missing?
4. Ok, so give me checklist of what I should be doing?

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1. The facts - how do cheap home loan rates work?: SBI slashed home loan rates to attract different customers across different income segments. Conceptually, this is how it works. The bank has offered teaser rates for the first 3 years, depending upon the size of the loan, below Rs 5 lakhs or above. During this period, the rate adjusts to a higher amount by about 0.5%. Then around the year 4 mark of the loan, the loan gets further adjusted depending upon the then prevailing in-house rate of interest that the bank prices all other loans at.
   For example, for loans between Rs 5 lakhs to Rs 50 lakhs, SBI will charge 8% in year 1, and 8.5% in years 2 and 3. From year 4 the borrower can choose between a floating rate of 2.75% below the State Bank Average Rate (SBAR) and a fixed rate of 1.25% below SBAR. There is no way of knowing today what SBAR is going to be a few years from now, because this rate is set internally by the bank.
2. But, aren't cheaper rates good for me?: Sure, cheaper rates are good because they result in lower EMI payments. However, this is not all. These rates re-adjust upwards.
   Experience has shown, particularly during the sub-prime crisis in the US, that those who took low teaser rates to buy homes, tempted by cheap rates were often the ones who ended up in financial trouble a few years later. This is because when the rates adjusted upwards, they did not have sufficient income to pay the higher EMI.
   We are not arguing that SBI is doing a bad thing and that their actions will result in a crisis. We are just cautioning that these rates should not be as tempting as they appear. And here are some reasons why...
3. What am I missing?:
   1. Understand long-term implications: Home loans are long-term borrowings, often with a tenure of up to 10-20 years. So what you should really be thinking about is if you going to be better off in the long-term or not and not just in the first year. Don't just fall into the trap of a low teaser rate and get locked into an inflexible arrangement. Has your lender explained to you the long-term implications on your finances of taking a loan with a low teaser that resets in a few years time?
   2. Do you understand what the Prime Lending Rate is (PLR): Every bank has an internal interest rate according which all other loan rates are priced. The bank has full discretion to set this as it pleases. The details of how the PLR are arrived at are confusing to the common person, and the bank can exploit this ambiguity to its advantage. Ask your lender to explain to you how the bank's PLR might fluctuate and how these changes might affect you.
   3. Penalty for balance transfer: Understand if there will be a penalty for a balance transfer. You might realize a few years into your loan that another bank is offering you better overall terms, but that you will not be able to transfer your balance to that bank because your current bank is charging a high penalty for transferring the loan. Lenders waive the prepayment fees if you pay out of your own funds, but then why would you take a loan if you had the funds in the first place. Could the penalty fees be too high that it offsets any benefit of taking a home loan with a cheap teaser rate? Understand how flexible your lender is going to be.
   4. Processing headaches and customer service: Most critically, understand the customer service aspect of your loan. We have seen enough clients go for cheap teaser rates from banks, only to suffer because the disbursement is not made on time. Don't fall for a low rate only to be hit with the possible reality that your purchase might be delayed because the lender is not processing your file on time. Often the bank will publicize the low rate to tempt you, but when they see your background will not lend to you at that lower rate.
4. Ok, so give me checklist of what I should be doing?:
   1. Ask your lender to give you a calculation of your EMI schedule - can you afford it when the rate resets
   2. Understand all the terms and conditions, particularly around exit penalties
   3. Get a commitment on when your file will be processed by and ask for an upfront list of all the documentation the lender needs
   4. Compare and review different lenders, as your friends about their experience with different lenders
   5. Bargain with the lender to reduce any charges or terms that might be unacceptable to you

Comments

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varun said : 13/08/2009	what are you trying to say....not understandable....i think the worst topic so far in your website
Prasun Banerjee said : 12/08/2009	Unbelievably misleading title from a team that prides its trustworthiness !!! Can you please be clear what are you arguing about ? The tone of the article is about getting a better view of the fine print of cheap loans. But when you title it as "Cheapest homes loans might not be the best for you" , i would like to know what alternates are you suggesting ? Are you saying expensive loans are better ? Whether cheap or not , everyone has to go through the fine print of a loan. All loans whether cheap or not are linked to PLR of a bank and noone can predict with certainty on PLR movement. So why single out SBI / cheap loans ? If you track the PLR movement of all banks , you will find SBI / PSU banks to have the least volatility in PLR. The checklist you have is a must for any loan. Why cheap loans only ? Please clarify the title of your article !!!